The IMF has upgraded the emerging economies? growth forecasts and downgraded the developed countries?. This is most likely to turn out right. We can expect the developed economies to be stagnant for much of the next decade. They have a huge hangover of private and public debt that needs to be sorted out. The recent change of mood in G-20 and even the IMF is to tackle this deficit urgently to allow growth to resume. Many Keynesian economists?Paul Krugman, Robert Skidelsky, Joe Stiglitz?are opposed to this deficit cutting policy. They are advocating a sustained reflation strategy. Their hope is that the output lost during the Great Recession?around 5-7% of GDP on an average in each country?should be recovered before restraint can be practised. They would steer the economy to overshoot its historic growth path and then gently converge from above to the trend growth rate.
I am sceptical of this because I think the multipliers are rather small. This has been known for a while. For example, in the first quarter figures for the UK, there was a growth of 0.3% of GDP and 1.5% growth of government spending. Even if you annualise the 0.3% growth, the multiplier is barely one. This, if true, would imply that the reflation package may need to be big and sustained for two to three years to achieve what the Keynesians want. I think it is unlikely that the developed economies can borrow to that extent without paying some hefty interest rates.
Against this, it is contended that the domestic corporate sector are in surplus and they will hold the debt. But if so, that will not lead to growth (since public spending has a low multiplier) nor is it certain that all the developed countries can manage to borrow at home. We have already seen how Greece has been struggling along with Spain, Portugal and Italy. Indeed, in both Greece and Spain, China is stepping in as a big buyer of the local assets. Sovereign wealth funds from the Gulf countries will no doubt follow.
The global economy has the developed economies as net debtors and the emerging economies as net creditors. I would aver that we ought to change the labels now. The label ?emerging economies? is too patronising for what are, after all, the fast growing economies of the last two decades. By contrast, the only way to label the Eurozone economies is as submerging. The Anglo-Saxon economies?the US, the UK, Canada and Australia?will do a bit better but not by much. This is not an accident nor a result of the Great Recession. It is indeed the other way round. What we are witnessing is the long-run consequence of adopting full employment and low inflation policies, which presumed but did not pursue growth. This has been the legacy of Keynes, and, after the 1970?s, of the new classical economics.
In pursuing high employment strategies, governments did not worry about the productivity of the jobs they were creating. Keynes was writing about the short run and he was worried more about the cost of unemployed labour than the problem of low productivity when this idle labour was employed. The western world had a 25-year period of growth from 1945 to 1970, the so-called Keynesian golden age. This growth was a result of catching up with pent-up demand of the baby-boom generation and using up all the innovations of the War and pre-War years. There was still surplus labour on the farms, even in the US and Western Europe that kept wages in line with productivity. The growth was one of widening rather than deepening variety.
When this growth spurt was exhausted, Keynesian policies began to fail in the 1970?s. There was no positive growth policy to correct this failure. The macroeconomic thinking turned to reducing inflation and the idea was that growth would be taken care of by the market. The Silicon Valley did for a while meet this expectation, but soon the growth spurt was exhausted as we saw in the collapse of the dot-com boom. New classical economics is as little concerned with growth as was Keynesian economics. Now with the easy pickings of high-level consumer demand having been exhausted, the wellsprings of growth seem to have dried up for the developed countries.
The long-run growth challenge, thus, requires a rebooting of economics away from Keynesian and new classical macroeconomics towards a classical and Schumpeterian economics. It should emphasise investment and innovation rather than consumption, supply rather than demand, work rather than leisure, wealth creation rather than welfare provision. It is unlikely that this sort of economics will be easy to construct. But without that the developed economies face steady decline relative to the fast-growing economies of Asia and Latin America.
The author is a prominent economist and Labour peer
